Public Goods and Private Communities: The Market Provision of Social Services

A Valuable Analysis of Public Goods and Public Finance

The primary purpose of academic programs in urban economics is to train central planners. Traditionally college courses in state and local public finance and urban economics have rationalized everything that local governments do, while invoking elaborate formulations about how these governments might do what they do more “efficiently.” Dr. Fred Foldvary’s new book, Public Goods and Private Communities, turns the standard model of urban economics and local public finance on its head. He first argues that the economic theory of public goods, which supposedly “justifies” government provision of many goods and services, is irreparably flawed. He then argues that most if not all of the services that local governments provide can be, and are, provided more efficiently through private contractual arrangements.

Courses in public finance all begin by discussing the theory of “public goods.” Basically a good or service is said to have “public” characteristics if private producers cannot capture all of the benefits associated with its consumption. The idea is that once such a good is produced people can enjoy the benefits that it provides without having to pay for them. Consequently, it is argued that public goods will either be “underproduced” in the free market or not produced at all. The government therefore should either subsidize their production or simply produce these goods or services and pay for them through taxation.

As an example Dr. Foldvary uses the building of a dam that would provide flood prevention services to a community. It is easy to see how once the dam is produced, anyone living in the area would automatically receive the flood prevention benefits whether or not they pay for them. This is the so-called free rider problem. Public goods theory argues that people will not voluntarily pay for such services and the private sector would have no incentive to undertake projects like the dam. Other frequently cited examples of public goods include roads, parks, police and fire protection, national defense, and education. The theory of public goods allegedly provides the economic justification for extensive government involvement in these and many other areas.

Foldvary attacks the standard theory of public goods from several perspectives. Drawing on arguments made by “public choice” economists, he points out that there is no reason to expect the government to succeed where the market has supposedly failed. Once the political process, dominated by special interests and the self-interest of politicians and bureaucrats, is analyzed, the economic efficiency justification for government provision of “public goods” falls apart. There is no reason to favor the results of the political process, even over the caricatured results of the free market that are described in the theory of public goods. Even on its own terms, the policy conclusion of public goods theory simply substitutes government failure for “market failure.”

Foldvary also argues that public goods theory starts with faulty assumptions about the real world—namely that people live atomistically rather than in geographically defined communities and that public goods must be provided in isolation from private goods. His analysis challenges these assumptions. More realistically, he assumes that people live in communities where societal pressures can be brought to bear on would-be free riders and that the provision of public goods can be “tied” to the provision of private and excludable goods.

Foldvary argues that there is no reason to expect that public goods will not get produced through private contractual arrangements. Drawing on the works of “Austrian” and “constitutional” economists such as F. A. Hayek, James Buchanan, and Richard Wagner, Foldvary advances an economic theory that explains what is observed in real world communities around the country, i.e., the private provision of public goods and services. It is a phenomenon observed in private neighborhood associations, planned communities, apartment complexes, condominium associations, and even shopping malls and amusement parks. All of these represent communities, i.e., voluntary social arrangements, of one form or another. They also require as a condition of membership (to invoke the analogy of a club) the purchase of a bundle of public and private goods. For example one might buy into a condominium association because he wants the private services of having his lawn mowed or the use of tennis courts. But these services are typically “tied” to the provision of other more “public” goods and services such as the provision and maintenance of roads or police protection, i.e., security guards.

Foldvary illustrates his theory with a number of case studies. He examines several institutional arrangements that have successfully dealt with public goods and free-rider problems. These include Walt Disney World in Orlando, Florida; the community of Arden in Delaware, where buildings are privately owned but all land is owned by a private trust that charges rent and provides public services (founded in 1900 by followers of Henry George); the Ft. Ellsworth Condominium Association in Alexandria, Va.; and the massive “planned” contractual community of Reston, Virginia.

Foldvary’s book also provides a valuable explanation of why private communities that collect fees for the privilege of living there aren’t the same as governments. He gives some convincing reasons. First, such communities are based on an explicit contractual arrangement. All the standard laws of contract apply, including the right to sue because of breach of contract. Second, the powers of the neighborhood association are limited to those specified in the contractual arrangement. Third, the community association does not have the power to redistribute wealth, which is a standard use of tax revenues. Lastly, decision-making power within the contractual arrangement is typically held by property owners only. As Foldvary points out, under government democracies property owners typically “have no more voting power than other residents.”

Fred Foldvary has made a valuable contribution to the economic literature on public goods and public finance. If it is fully appreciated by the economics profession it could revolutionize and dramatically improve the study of urban economics specifically and public economics in general. Unfortunately it is not in the interest of individual economists to buck the system as it currently exists. In this sense maybe Dr. Foldvary’s book, itself, should be the subject of some public goods analysis. []

Dr. Cordato is Lundy Professor of Business Philosophy at Campbell University, Buies Creek, North Carolina.

ABOUT

Roy Cordato is the Vice President for Research and resident scholar at the John Locke Foundation. He is a member of the Mont Pelerin Society and the former executive board member of The Association of Private Enterprise Education. He holds an M.A. in urban and regional economics from the University of Hartford and a Ph.D. in economics from George Mason University.

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December 2014

Unfortunately, educating people about phenomena that are counterintuitive, not-so-easy to remember, and suggest our individual lack of human control (for starters) can seem like an uphill battle in the war of ideas. So we sally forth into a kind of wilderness, an economic fairyland. We are myth busters in a world where people crave myths more than reality. Why do they so readily embrace untruth? Primarily because the immediate costs of doing so are so low and the psychic benefits are so high.